There has arguably not been a hotter investment opportunity in 2017 than cryptocurrencies, which as an aggregate had seen their market caps grow by more than 800% at one point, year to date. But no cryptocurrency is more popular than bitcoin, which comprises nearly half of the digital currency market cap despite there being almost 1,000 cryptocurrencies consumers can purchase. Bitcoin began the year below $970 a coin, but recently neared the $5,000 mark.
Three reasons bitcoin is so hot in 2017
Weakness in the U.S. dollar is a big reason why cryptocurrency prices have been on fire. A weaker dollar is great for U.S. exports, but it's not such great news for investors or consumers who are witnessing their purchasing power deteriorate. Investors will usually seek the safety of gold when the dollar is sinking since gold is a finite resource that's been used as a currency for centuries. However, cryptocurrencies like bitcoin have been just as popular (if not more popular) of late, given that protocols within bitcoin limit the number of coins that can be mined to 21 million. In effect, bitcoin is a finite resource, too, making it a perceived store of value as the dollar falls.
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There's also tons of buzz surrounding the blockchain technology that underlies digital currencies like bitcoin. Blockchain is the decentralized digital ledger that records transactions. It's believed to be a considerable step up in safety and security compared to how peer-to-peer, client-to-business, and business-to-business transactions are currently conducted. Bitcoin's recently completed fork, whereby it split into two separate currencies, bitcoin and bitcoin cash, allowed for an upgrade to bitcoin's primary network that should appeal to businesses. The SegWit2X update should help reduce transaction fees, speed transaction processing times, and improve capacity. Investors in bitcoin are counting on bitcoin's upgraded blockchain to attract new channels for expansion.
Lastly, momentum has also been a driving force for bitcoin. Bitcoin has more than tripled year-to-date, which is a better return than the S&P 500 has delivered since hitting its Great Recession lows eight years ago. Other cryptocurrencies have fared even better, with ethereum up well over 3,000% year to date. Gains like this can draw in inexperienced and emotional investors, who in turn can push prices even higher.
Is the bitcoin bubble starting to pop?
However, bitcoin's gains could prove short-lived. Over the past 12 days, through Sept. 12, bitcoin has lost almost $900, or close to 18% of its value. In terms of market cap, we're talking about nearly $15 billion erased in just two weeks' time.
Why, you ask? To begin with, China is looking like a major obstacle for bitcoin's expansion. Though China could be a source of immense growth for cryptocurrencies like bitcoin given its rapid growth rate and burgeoning middle class, the country has cracked down on bitcoin in recent days.
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On Sept. 4, China announced that it was banning fundraising through initial coin offerings, or ICOs. Documents suggest that China fears the potential for "financial scams" with ICOs, and it's banning banks and financial institutions from any business related to ICO trading. Just a week after its announcement on ICOs, anonymous sources told The Wall Street Journal that China may also seek to shutdown domestic bitcoin exchanges. While no decision has been made on this latter rumor, it's clearly sending shockwaves throughout the cryptocurrency markets.
Another issue is that we really don't know what the blockchains behind most digital currencies are really worth. Right now, more than 150 organizations are testing a version of ethereum's blockchain technology in pilot and small-scale projects, but that doesn't exactly ensure that blockchain is the transaction-based technology of the future. Further, even if it is, there's no telling if bitcoin, ethereum, or some other network could be the preferred blockchain of choice. After all, six global banks announced that they were forging an alliance to create their own cryptocurrency, known as utility coin, two weeks ago. The barrier to entry is pretty low among digital currencies, meaning even bitcoin could be fleeting.
Bitcoin's bubble comes to Wall Street
But the most pervasive evidence that the bitcoin bubble could be near bursting comes from Wall Street; or more specifically the recent implosion of First Bitcoin Capital Corp. (BITCF +0.00%).
First Bitcoin Capitol Corp. is a company that develops digital currencies, proprietary blockchain technologies, and digital currency exchanges, which as you might imagine speaks to the heart of the cryptocurrency revolution. As recently as Aug. 14, First Bitcoin Capital's share price soared intraday to nearly touch a $1 billion market cap.
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However, a quick peek at its latest financial statement shows that it has just over $2,000 in cash and $360,000 worth of Venezuelan gold-mine assets on its books, dating back to when the company was focused on acquiring gold assets. At this point, there's little evidence to suggest that it has anything meaningful ongoing regarding cryptocurrencies. Following a two-week trading halt by the Securities and Exchange Commission, First Bitcoin Capitol reopened for trading this week and has plunged by 80% in just two days. Investors are finally digging below the surface and finding that there's simply nothing there to support these lofty valuations. Now First Bitcoin Capital gets to deal with a flurry of lawsuits filed on investors' behalf.
What could be next? Perhaps the Bitcoin Investment Trust (GBTC +1.23%) operated by Grayscale. This ETF owned 172,721 bitcoins as of Aug. 31, 2017, which based on bitcoin's $4,095 price as of Sept. 12 translates to a $707.3 million market value. However, the Bitcoin Investment Trust has regularly been valued at a 50% to 125% premium to its net asset value (NAV). Since Aug. 31, the Bitcoin Investment Trust has shed more than 30% of its value, and its premium to its NAV has "shrunk" to just 67%. Nevertheless, it makes little sense for investors to pay 67% more to own this ETF than the underlying value of its assets under management.
Is this the beginning of the bitcoin bubble bursting on Wall Street? It's certainly possible.
